Official Dollarization and the Banking System in Ecuador and El Salvador

In January 2000 Ecuador adopted the U.S. dollar as legal tender, and El Salvador followed suit in 2001. The two countries officially dollarized under quite different circumstances: Ecuador was suffering an economic and banking crisis, while El Salvador enjoyed economic stability and low inflation rates. This article studies the evolution of the banking system in these two countries before and after official, or full, dollarization.

In Ecuador the reforms that ensued from full dollarization have improved transparency and banking performance and competitiveness, but the implementation and enforcement of regulations remain weak, and accounting standards still deviate from international norms. In El Salvador, whose banking regulations are comparable to international standards, full dollarization has improved bank performance despite economic deceleration, increasing the banking system's competitiveness in Central America.

Overall, full dollarization has enabled both Ecuador and El Salvador to modernize and improve banking regulations and the safety and soundness of the banking system, the authors conclude. They find that official dollarization, along with other macroeconomic and financial structure factors, has played a significant role in improving bank liquidity and asset quality. Bank profitability has responded to variables that are bank specific.

It is still too early, the authors note, to predict whether dollarization's benefits will be sustainable over the long term.